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Reserve cuts to rein in heated dollar

The Reserve Bank has taken decisive steps to take the heat out of the high Australian dollar by cutting the cash rate to its lowest level in more than half a century.

The Reserve Bank has taken decisive steps to take the heat out of the high Australian dollar by cutting the cash rate to its lowest level in more than half a century.

Interest rates were lowered by 25 basis points to 2.75 per cent on Tuesday, the first reduction this year. The current easing cycle has seen 200 basis points of cuts since November 2011, bringing the cash rate below the emergency settings during the global financial crisis.

It is also the first time the RBA has cut interest rates below 3 per cent since it began setting monetary policy in 1990.

RBA governor Glenn Stevens (right) said low inflation gave the board scope to ease rates to support demand, adding a "further decline in the cash rate was appropriate to encourage sustainable growth in the economy".

"The RBA appears to have simply grown weary of a high Australian dollar, while becoming more comfortable about the ... pace of domestic inflation given the improving productivity trend," UBS economists Scott Haslem and George Tharenou said.

The Australian dollar lost half a cent after the decision, falling to as low as US101.78¢ before stabilising just below US102¢ about 5pm on Tuesday.

Three of the four big banks passed on the full cut, with ANZ set to make a decision on its standard variable mortgage rate on Friday as part of its monthly review.

The RBA decision came after a spate of soft economic data, which has called into question the strength of the housing recovery, while pointing to a rising unemployment rate, continued weakness in the manufacturing sector and slow private credit sector growth.

ANZ currency strategist Andrew Salter said the Reserve Bank was not targeting the currency directly but seeking to support the sectors battling against the stubbornly strong dollar.

"We've had indications in some of the economic data that the currency is having a contractionary impact and what the RBA is doing to reducing cash rates to offset that," he said.

The RBA's board members signalled in previous statements and speeches their concern about the high dollar despite the decline in export prices and interest rates.

Tuesday's statement put forward a stronger position, with Mr Stevens pointing out that the exchange rate "has been little changed at a historically high level over the past 18 months".

"It appears that [the Australian dollar] was a key motivation for today's cut," HSBC chief economist for Australia Paul Bloxham said, adding that their currency worries had gone "beyond jawboning".

The central bank had stopped short of directly stepping in to influence the currency.

Australia is one of the few countries in the world with a triple-A rating, making it more attractive to global funds looking for investment havens. At the same time, its cash rate is highest among developed countries despite being at historic lows domestically.

Quantitative easing measures by central banks have also depressed yields overseas, making the Australian currency more appealing to global investors.

Yet while the Reserve Bank retained an easing bias in Tuesday's statement and added it had used only "some of that scope" from low inflation to ease rates, economists said they did not expect another cut for a few months.

They said the cash rate was likely to remain lower for a longer period of time as compared with previous easing cycles, given the dollar's strength, low commodity prices and slowing growth in China.

"I think right now, they would expect to be on hold for the next few months as they wait for more information," UBS interest rate strategist Matthew Johnson said.

Mr Salter said the export-oriented sectors of the economy would continue to remain under pressure as the outlook for the Australian currency remained strong given the state of the world's financial markets.

What the bank said

Recent data on prices confirm that inflation is consistent with the target and, if anything, a little lower than expected.

. . . the Board has noted that interest rates have already been reduced substantially, with borrowing rates approaching previous lows, and that the effects of this on the economy are continuing to emerge.

The exchange rate . . . has been little changed at a historically high level over the past 18 months, which is unusual given the decline in export prices and interest rates during that time . . . the demand for credit remains, at this point, relatively subdued.

(The Board) judged that a further decline in the cash rate was appropriate to encourage sustainable growth in the economy, consistent with achieving the inflation target.

Extracts from a statement by Glenn Stevens, Governor of the Reserve Bank of Australia

The economists

‘‘[The Reserve appears to be saying] it is less confident that other sectors of the non-mining economy will strengthen as it hopes to offset the slowing in mining investment . . .we would expect many to characterise the move as insurance.’’

ANZ chief economist Ivan Colhoun

‘‘The Reserve’s views on global growth, domestic growth and the transition to non-mining-led growth seem little changed. Instead, the Reserve has used the lower-than expected [inflation data] to take the opportunity to speed up the baton pass to the non-mining sector.

’’ CBA economist Gareth Aird

‘‘It comes as a surprise that the Reserve hasn’t chosen to take amore cautious approach in reading some of the recent soft economic data, which tend to be volatile month-to-month.’’

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